By Jeff Harding.
*See disclosure at end
I’ve been thinking a lot about gold lately. Especially now that Nouriel Roubini has come out and trashed the noble metal (see Tyler Durden’s article). Anyone who tells you they know what’s going to happen with gold is guessing. Roubini is guessing.
Roubini also makes some fundamental errors in his analysis, and his assumptions are flawed. Since he’s my favorite playboy economist, I should point out that he did study at the Mises Institute, but he must have cut class. He is ½ Keynesian, ½ Monetarist, and ¼ Austrian (according to Keynesian econometrics).
My conclusion, an admitted guess, is that the trend for gold is up. But … it depends on what the government and the Fed will do. The short term is a trader’s nightmare, so I don’t have a clue if it’s going up or down tomorrow. The bubble seems to be subsiding. If I were to really go out on a limb, I would guess that the fiscal stimulus bump will continue through Q1 2010, but will wear off by Q2–Q3 2010. Good GDP numbers would have negative effect on gold.
Let me explain why I think the way I think. In part it is an answer to Roubini. I could go through his report point by point, but I would rather make my own case. I don’t mean to sound pedantic, but reviewing the basics helps give perspective to the issue.
1. People want gold.
People flee to gold when they believe the future is uncertain. And you can’t tell me people like gold jewelry just because it’s pretty. It has always been that way. There is no secret to its value. People want it, it’s in short supply, you can’t make it, it’s been used as money for millennia, and, well, people want it. Accept this fact.
If you thought your paper money was going to be devalued, or worse, worthless, you’d get into some hard asset. Gold works pretty well in these situations. It’s value will be maintained while fiat money could be wallpaper. People will take anything to get rid of their paper: bread, cigarettes, candy, grenades. Whatever. Gresham’s Law.
This underlies the value of gold.
2. Fear is driving gold.
The big fear out there is that the U.S. will eventually face high inflation, perhaps hyperinflation, and sovereigns and investors who hold dollars see gold as a hedge against that event. Stability in an unstable world.
If it were all trader-driven speculation, the bubble would pop and gold would be back to $*** (pick a number). But when you have China doubling its gold reserves, and India buying tons of gold, when guys like John Paulson, Paul Tudor Jones, and David Einhorn reveal they’ve been loading up on gold, you know something is going on.
There appears to be enough demand to create a floor which would limit a collapse of the price of gold.
3. Perspective.
According to the NBER, this is my 8th cycle. My mother sold her stocks at the bottom of the 1962 cycle (down about 12%). She confided that fact to me later that year when I came home from college after starting Econ 101. She went through the Depression and was afraid. I told her we’d never have another depression: my professor told me so. That was my first cycle.
The point of the experience thing is that during almost every big cycle I’ve been through, the gold bugs came out in force and predicted dire things. Look at the ads on a lot of blogs. Check out the survivalist sites. Gold, guns, and food. Atlas Shrugged. It is not a new thing. The predictions you see today are the same as in the past. It has a big impact on (younger) people who haven’t been through a major cycle before. Everything is new in their eyes.
Also, for the most part, gold bugs always like gold. They believe the world will come to an end, soon.
Because people say it, doesn’t mean it’s so.
4. Is this cycle different?
Yes, it’s different. It’s huge. … Continue reading Whither Gold, That Barbarous Relic
By Jeff Harding.
In a Bloomberg interview today, Steven Roach, Chairman of Morgan Stanley Asia said:
China needs to boost investment in social security, private pensions, and insurance for unemployment and medical care, Roach said, to prompt its consumers to save less and buy more goods from overseas.
Japan vs. U.S.: Compare and Contrast
By Jeff Harding.
Japan has been in decline, or at least stagnation, for 19 years. Their GDP has not grown, unless you consider 0.6% (avg.) robust annual growth. They have experienced a deflationary economy, and now, it’s happening once again. They now have the highest national debt as a percentage of GDP than any other major economy. It has been argued that the U.S. is catching this Japanese “disease” and that not only will we have continued deflation, but also stagnation.
I went back and read my background material on Japan’s economic history, starting with the Bank of Japan’s money pumping in 1986, and was startled to see the similarities between the policies of Japan to stimulate its economy and what we are now doing. My last major article on this topic, The Japanese Disease, was written in January, 2009, just as our government was ramping up their fiscal stimulus programs, and things have changed quite a bit since then.
It is easy to say that because we have adopted many of the same Keynesian policies that failed in Japan, not only will they fail here, but that the economic results will be identical. As I write this, I am not sure the economic results will not be the same, but I think there are several major differences between Japan and the U.S. that may lead us to somewhat different results. It depends what the government will do.
Here’s a quick summary of Japan’s experience (excerpted from my January article):
They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987. The result:
- Real estate and equity prices soared.
- To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
- The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
- GDP grew at only 1.17% from 1992 to 2003.
- Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
- Consumption and investment fell dramatically.
- Banks were not lending.
What was the response of the government to this crisis?
- In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
- From 1992 to 1995 they spent ¥65.5 trillion on projects and cut taxes.
- In 1998 they cut taxes ¥2 trillion.
- In 1998 they spent another ¥40.6 trillion on spending stimulus.
- In 1999 they spent another ¥18 trillion in fiscal stimulus.
- In 2000 they tried another ¥11 trillion spending package.
- They set up a ¥20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
- To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of ¥2.22 trillion.
- Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
- They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.
It is estimated that the Japanese spent about $1 trillion about (¥135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP [it's now 200%], and the yen devalued. Nothing seemed to work.
Remember some of the hallmarks of the Japanese experience? “Zombie Banks” were banks that the government allowed to keep their doors open although they were really insolvent. “Zombie Corporations” were the companies whose debt were held by zombie banks, but were allowed to stay in business because the zombie banks didn’t write off these loans. “Window sitters,” a term applied to workers of zombie companies who showed up for work every day for a paycheck, presumably gazing out the window all day with nothing to do.
The irony of it is that they are trying the same things again in this crisis, with the same results. The Bank of Japan just predicted two years more of deflation, and unemployment is up to 5.5%. Exports, the mainstay of their economy, are falling off a cliff (11 straight months of decline). It reminds me of a definition of insanity: expecting a different result to occur from the same input, over and over again.
Does the Japanese scenario sound familiar? It should since we are doing most of the same things as they did.
- The Fed reduced the Fed Funds rate to 0.25%.
- The government has hugely increased the base money supply in an attempt to create inflation.
- The government has spent or pledged about $2.7 trillion dollars in direct loans, bailouts, debt purchases, grants, and wasteful spending projects.
- The guarantees to Fannie, Freddie, Sallie, and the FHA, plus additional backstop guarantees by the Fed and the Treasury amount to almost $10 trillion.
- The Obama Administration expects the national debt is to increase by almost $10 trillion over the next 10 years (a very conservative number considering the new national health care plans). This will get us to a national debt of about 200% of GDP.
- Programs like Cash for Clunkers, Cash for Refrigerators, and Cash for Casas are trying to stimulate consumer spending and increase consumer debt.
- Like Japan, mark-to-market accounting requirements for banks have been partially suspended.
- The Fed has been directly financing corporations through its commercial paper lending window.
- TARP, TALF and the host of other programs were implemented to keep bankrupt institutions afloat.
- They have been buying stock in financial and commercial companies.
- They have been buying U.S. debt, effectively partially monetizing the deficit.
It is not surprising that these policies have led us to many of the same results as Japan experienced:
- Deflation.
- Collapsing real estate values.
- A shrinking money supply.
- Decreased bank lending.
- Falling consumer spending.
- Falling consumer credit.
- Increased federal debt.
- Falling GDP.
- High unemployment.
One might ask, with all this faith in Keynesian policies, why aren’t they working? Why are we still having these problems? And, why aren’t we doing something different than Japan? … Continue reading Will We Have a Lost Decade(s) Like Japan?
By Jeff Harding
I think that Peter Schiff has it right. My take is that the Fed is in a bind and will either hike interest rates or let the dollar fall and impose price and wage controls.
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By Jeff Harding
To follow up on yesterday’s article on China’s dilemma—the $1.5 trillion is US debt they hold—it seems that this week’s Treasury auctions ran into trouble:
Shaky auctions of Treasury notes this week reignited concerns about whether the government can attract buyers from China and elsewhere to soak up trillions in new [...]
By Jeff Harding
Here are the latest musings by David Rosenberg, Chief Economist at Gluskin Sheff, formerly Chief Economist for Merrill Lynch, who called the Crash. He’s always worth listening to.
IS THE U.S. DOLLAR NEXT?
It is the second anniversary of the credit crunch and after all of the fiscal and monetary policy initiatives, the best we get are ‘green shoots’ and now that story is getting stale. Go back two years and you will see that the funds rate was 5.25%. Today it is zero. The fiscal deficit was 2.0% of GDP two years ago. Today it is 13%. Mortgage rates were 6.5%. Today they are 4.7%. Homeowner affordability with all the government measures is 70% stronger today than it was then too. The Fed’s balance sheet then was $850 billion. Today it is bloated at $2 trillion. The government has tried just about everything. Or has it? What if we were to tell you that the one policy tool that is unchanged since the summer of 2007 is … the U.S. dollar? It is exactly the same level now, on any trade-weighted measure, as it was back then. The greenback is struggling at the 50-day moving average, and this could well be the next policy shoe to drop.
If we would have told you two years ago that we would have a deficit/GDP ratio of 13% and a Fed funds rate of 0%, would you have believed that real GDP growth would still be negative? Two years ago, it was running at nearly 5%. The unemployment rate was at 4.7% — today it is twice that level. The S&P 500 was 1,550 — today the bulls are content with 930. Consumer confidence was 111 — today it is 49. The inflation rate was nearly 3.0% then, it is -1.4% now. All this, two years after the onset of the most dramatic monetary, credit and fiscal policy easing in 70 years. … Continue reading The Future of the Dollar
Here’s the first serious salvo across the bow of the USS Greenback. The head of China’s central bank said the dollar ought to be replaced by another reserve currency. Here’s the gist of the article in the Wall Street Journal:
China called for the creation of a new currency to eventually replace the dollar as the world’s standard, proposing a sweeping overhaul of global finance that reflects developing nations’ growing unhappiness with the U.S. role in the world economy…
Chinese officials are frustrated at their financial dependence on the U.S., with Premier Wen Jiabao this month publicly expressing “worries” over China’s significant holdings of U.S. government bonds. The size of those holdings means the value of the national rainy-day fund is mainly driven by factors China has little control over, such as fluctuations in the value of the dollar and changes in U.S. economic policies…
In recent weeks, senior Obama administration officials have sought to reassure Beijing that the current U.S. spending spree is a short-term effort to restart the stalled American economy, not evidence of long-term U.S. profligacy…
Mr. Zhou’s [governor of the People’s Bank of China] comments — coming on the heels of Mr. Wen’s musing about the safety of China’s dollar holdings — appear to be a warning to the U.S. that it can’t expect China to finance its spending indefinitely.
 Zhou Xiaochuan
Mr. Wen had the temerity to suggest that replacing the dollar with a basket of currencies created by the IMF would be good for us because it would put a limit on our profligate ways. Those ways, he noted, led to the collapse of most world economies.
China has a problem because in large part its economy is tied to ours. They ship their goods to us because the price is right and we ship them back green pieces of paper called “dollars.” When the Chinese sellers of goods receive those dollars, they, in turn, are forced to exchange them for yuan at the official exchange rate. The Chinese government ends up with $1.95 trillion and needs to do something with them.
If they let the market determine the value of their yuan, it would go up in price and the dollar would go down. This would mean the dollars they hold would be worth less in relation to the yuan and it would also make foreign goods more expensive for them. They have tried to prevent this by tying the value of the yuan to the value of the dollar. If the dollar goes down, the yuan goes down, etc. So the relative value of the yuan-dollar exchange rate stays the same. … Continue reading The Chinese Aren’t As Dumb As the Fed Thought
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